Turkey — a Key NATO Player — Is Headed for Serious Economic Turmoil

So much for Erdoganomics.

With Turkey’s inflation surging and a balance-of-payments crisis looming, President Recep Tayyip Erdogan has been forced to backpedal hard on his highly unorthodox economic policy by finally allowing the central bank to hike interest rates to a jaw-dropping 25%, a 7.5 percentage-point jump.

This makes it all too likely that the chickens of Erdogan’s prolonged period of economic mismanagement will soon come home to roost in the form of a very hard Turkish economic landing.

That could have large geopolitical repercussions, given Turkey’s key position in the Middle East and Erdogan’s continued antagonism to the United States.

In recent years, Erdogan’s economic policy approach has rested on his strongly held belief that far from helping to combat high inflation, high interest rates were inflation’s principal cause.

This induced him over the past year to pressure the central bank to progressively more than halve interest rates to 8.5% at a time when inflation was climbing to as high as 60%.

The fact that Erdogan was cutting interest rates at a time when most major central banks were hiking rates to regain control of inflation underlined how highly unorthodox his policy was.

Aside from causing the economy to overheat and inflation to soar, Erdogan’s approach caused the currency, the Turkish lira, to plummet and Turkey’s balance of payments to deteriorate.

Meanwhile, in the first quarter of this year, the country’s external current account deficit ballooned to almost 10% of GDP.

To say that Erdogan’s reckless interest rates heightened the country’s external economic vulnerability would be an understatement.

Indeed, the central bank’s international reserves have dipped into negative territory despite the fact that the bank has borrowed very large amounts of foreign exchange deposits from the domestic banks.

At the same time, the government has had to guarantee as much as $125 billion in domestic bank deposits against exchange rate depreciation.

All of this has raised serious questions about Turkey’s longer-term economic outlook and its role as a key player in the Middle East and NATO.

Can inflation be brought down to single digits from its present lofty levels of close to 50% without throwing the country into a deep economic recession?

How long can Turkey rely on the kindness of foreign governments to help finance its gaping external current account deficit?

How will Turkey’s banks find the dollars to meet their depositors’ demands for dollars should they choose to withdraw their large dollar deposits?

How badly will the country’s public finances be impacted by the government’s past exchange-rate guarantee to domestic depositors?

The key ingredient of any policy strategy to address Turkey’s deep economic problems would be the early restoration of domestic and foreign investor confidence.

Erdogan’s recent installation of a more orthodox economic team at both the Turkish Central Bank and the Ministry of Finance is a good step in that direction.

So too is his decision to allow the central bank to raise interest rates rapidly to their present level of 25%.

However, given Erdogan’s highly erratic economic policy record, it’s doubtful that those first steps will be nearly sufficient to restore investor confidence and stabilize the economy.

After all, in the recent past, Erdogan had no hesitation in firing as many as three central bank governors and replacing a host of other economic officials who had the temerity to question the wisdom of his unorthodox approach.

The one institution that could help Turkey back to economic health is the International Monetary Fund.

It could do so by providing Turkey’s economic policy with a much-needed seal of approval and by offering large-scale financing to help meet its immediate external financing needs.

However, calling in the IMF and subjecting himself to its loan conditionality would constitute a huge loss of face for Erdogan.

I don’t suggest holding your breath for that to happen before a further deepening of Turkey’s economic crisis.